Further thoughts on pricing strength of a business

November 13, 2006

The following question was posed to me by Prem sagar on my previous post. The question made me think and I am posting my thoughts on what I think is a fairly important issue in investing (earlier post on pricing )

But what would u say for an industry like say auto ancillaries or retail-proxies like Bartronics, control print, etc where the opportunity is huge, but they have little or no pricing power?

According to me, pricing is an important variable to evaluate the presence of a competitive advantage or strength. A company with strong pricing power, will be able to sustain high returns for a long time and can increase its intrinsic value over time too. So if one were to buy a company with strong pricing power (with other factors in favour), then it is likely that the investment would work out well with passage of time as the company increases its intrinsic value. So such companies can be long term holdings in a portfolio

That said, it does not mean that companies without pricing power would not be good investments. If one can find a company with low pricing power (commodity business), but with some kind of competitive advantage and selling below its intrinsic value, then such a company can be good investment. I would however not hold such an investment too long, once the stock price is close to the intrinsic value as the likelyhood of an increase in the intrinsic value is less.

I do not have much insight into retail-proxies. However as far as auto-ancillaries are concerned, I have done a bit of analysis ( see here, and here) and have not found too many companies to invest in (mainly due to valuation issues). By the very nature of the industry, these companies have poor pricing power (except for retail), have a few large buyers (OEM) and not many have achieved economies of scale in their operation (this industry is still fairly fragmented). However some auto-ancillaries do posses a few competitive advantages such as a low cost position due to focus on specific segment (fasteners for sundaram clayton?) and good growth opportunities. However as I have written earlier, I would invest in these companies only at a fair discount to intrinsic value and sell once the stock reaches the intrinsic value. I would really not hold the stock for a long term.


3 Responses to “Further thoughts on pricing strength of a business”

  1. Prem Sagar Says:

    Hi Rohit,
    Nice analysis. I agree auto anc and retail proxies are slightly different in nature.(I think I will call retail-proxies as retail ancillaries).

    But retail anc’s (not sure if I can call them this) interest me too. I have stayed at 3 cities Blore, Pune and Hyderabad. I can surely see a retail revolution. But there is too much competition amongst the retail players to offer lowest costs, comprehensive service, great shopping experience,etc..

    I am looking at all those ppl who can help them cut costs..
    The industry looks abuzz with RIL entering and projecting 90000 Cr revenues by 2010.

    Here the retail opportunity is huge. The pie is itself huge for the retail anc’s and demand cant be met atleast until next 2-4 yrs I guess.

    I am looking at ppl who can help them cut costs… mainly the barcoders, the RFIDs,inventory trackers, etc kinda ppl.

    I agree this too will finally behave like auto anc’s but I believe retail is not as cyclical as autos.

    This area certainly can be exploited, either sector wise or through clever individual stock picks. I remember, during the gold rush it was the pick-axe and spade sellers who made more money than the gold explorers themselves. I see something similar to that in retail.

  2. Rohit Says:

    hi prem
    agree with your comments. have done a bit of analysis on the retail sector. but i found the sector to be fairly valued. most stocks are quoting at premium prices. the market seems to incorporate all the pluses in the retail sector.
    i have not checked on any other companies which are suppliers to the retail business, so do not have much insight in that.

  3. Kotekoppa Says:

    Hi! I am new to this blog!!etc. So I may not be following the correct thread. I have a question.How do I create a stock screen consisting of the multiple criterion as you have talked about? In ICICIdirect site I got only a few preset criterions.

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